Question

Thompson’s Tree Farm is considering the replacement of its large delivery tractor and trailor. The old truck originally cost $ 60,000 when it was purchased one year ago.It is being depreciated over a six year life to zero book value.Thompson believes that the remaining useful life of the old truck is five years after which it will have a resale value of zero.The company can sell the truck now for$ 14,000.

        The new truck will cost $90,000 and will be depreciated over a five year period to a zero book value.At the end of five years it will be sold for $20,000.The new truck will produce cash savings of $ 23,000.The company’s tax rate is 40% and uses straight line depreciation.The required rate of return for the project is 10%.

          a.Find the project’s initial outlay.

         b.Find the project’s operating and terminal cash flows from years 1through 5.

         c.Evaluate the project using NPV.                                    

answers

Inıtial outlay= $61,600 NOCF= $17,000    Terminal CF= $12000

NPV= $10,294

Answer 1

a)	Cost of the new truck		$        90,000
	Less: After tax sale value of the old truck:
	Sale value	$         14,000
	Book value = 60000-(60000/6)*1 =	$         50,000
	Loss on sale	$         36,000
	Tax shield on loss at 40% = 36000*40% =	$         14,400
	After tax sale value of old truck = 14000+14400 =		$        28,400
	Initial outlay		$        61,600
b)	Operating cash flow:
	Annual cash savings	$         23,000
	Incremental depreciation:
	Depreciation of new truck = 90000/5 =	$         18,000
	Depreciation of old = 60000/6 =	$         10,000
	Incremental depreciation	$            8,000
	Incremental NOI	$         15,000
	Tax at 40%	$            6,000
	Incremental NOPAT	$            9,000
	Add: Incremental depreciation	$            8,000
	Annual incremental OCF	$         17,000
	Terminal cash flow:
	After tax sale value of new truck = 20000*(1-40%) =	$         12,000
	Less: After tax sale value of the old truck	$                   -
	Terminal CF	$         12,000
c)	NPV = -61600+17000*(1.1^5-1)/(0.1*1.1^5)+12000/1.1^5 =	$         10,294